Seeking Alpha
Deep value, value, contrarian, special situations
Profile| Send Message|
( followers)  

Summary

  • Walgreen's shares plummeted over 14% after news broke that it would acquire the rest of Alliance Boots but not engage in a tax inversion.
  • Management is forgoing attractive profit by not inverting, but it's possible that the long-term success of the business will benefit greatly from staying domiciled in the U.S.
  • Even without redomiciling, the combined company, Walgreens Boots Alliance, will be extremely large and diverse.

One of the worst-performing stocks on Aug. 6 was Walgreen (WAG). After news broke that the company would be accelerating its plan to acquire Alliance Boots but that it wouldn't use the opportunity to engage in a tax inversion, shares of the drugstore chain plummeted more than 14% to close at $59.21. With the company's stock trading 22% below its 52-week high of $76.39, is now a prime time to jump into the fray, or should investors look elsewhere to rivals like CVS Caremark (NYSE:CVS) or Rite Aid (NYSE:RAD) for superior returns?

Why not invert?

In the search for profits, a slew of companies, mostly pharmaceutical businesses, have made efforts to conduct tax inversions. Among these are AbbVie (NYSE:ABBV), which is buying Shire plc (NASDAQ:SHPG), Medtronic (NYSE:MDT), which is acquiring Covidien plc (NYSE:COV) and the attempted (but so far failed) buyout of AstraZeneca (NYSE:AZN) by Pfizer (NYSE:PFE). By buying a foreign company, primarily one based in Ireland, companies are able to reduce their effective tax rate because of a stipulation in the U.S. tax code.

When a domestic company acquires a foreign business and the acquisition results in the foreign country's citizens holding at least 20% of the combined company's shares, the combined company is able to redomicile itself for tax purposes in the country of its buyout candidate. In the case of Walgreen, acquiring Alliance Boots and inverting to Switzerland where its acquiree is based, would push the company's estimated tax rate down from 37.5% to 20%. Using Walgreen's 2013 earnings of $2.45 billion, a tax inversion would increase the company's bottom line by 27% from $3.12 billion.

What an Inversion Would Look Like
Walgreen: 37.5% rateWalgreen: 20% rateCVS CaremarkRite Aid
Net Profit Margin4.3%3.4%3.6%1%
P/E21272128

After this kind of move, the retailer's net profit margin would rise from 3.4% to 4.3% and its P/E Ratio (using its Aug. 5 closing price) would fall from 27 to 21. This would allow Walgreen to surpass rival CVS, in terms of profitability, whose net profit margin stands at 3.6% and widen its lead over Rite Aid, whose margin currently stands at about 1%. In addition to being more profitable, an inversion would bring the cost of Walgreen down to CVS's level which sports a P/E Ratio of 21 and would continue to outpace Rite Aid's P/E Ratio of 28.

Here's why

Despite major shareholders pressing for an inversion, management has been reluctant to follow suit. While profits would rise significantly under the deal, tax inversions have faced a great deal of scrutiny lately. The most recent blow in the assault against inversions has come from President Obama, who announced that he would seek for a way to end inversions on a retroactive basis, potentially interfering with current inversions that are taking place.

Another major concern likely facing management is the fear that an inversion might result in a loss of business in the U.S. According to the company's 2013 annual report, just 119 of its 8,582 locations in operation during the year were stationed outside the U.S. This converts to just over 1% of all stores, which could be abandoned by its customer base in the U.S. in favor of companies Obama would consider more "economically patriotic" like CVS or Rite Aid.

What will Walgreen look like after the acquisition?

In 2012, Walgreen acquired 45% of Alliance Boots in a transaction valued at $6.5 billion and, as part of the deal, locked in the right to buy the remaining 55% stake in the business in exchange for $5.29 billion in cash and 144.3 million of its shares. At Walgreen's closing share price of $59.21 on Aug. 6, this converts to an acquisition price of $13.8 billion, placing a value on all of Alliance Boots of $25.2 billion.

Walgreen: Today versus Tomorrow
Walgreen in 2013Walgreen in 2016 (forecasted)
Revenue$72.2 billion$126-$130 billion
Earnings per Share$2.56$4.25-$4.60

In exchange for this hefty valuation, Walgreen will receive an entity that diversifies its operations outside of the U.S. and, in 2016, is expected to raise Walgreen's consolidated sales to between $126 billion and $130 billion. For the year, the company, which Walgreen will call Walgreens Boots Alliance, is expected to post earnings per share somewhere between $4.25 and $4.60 (adjusted) in part due to $1 billion in estimated synergies that will develop over the course of three years.

If management's estimates are accurate, this means that Walgreen's revenue will be on par with the $126.8 billion CVS reported in 2013. When placed next to Rite Aid, the situation becomes even more extreme, with Walgreen's anticipated revenue coming in around 5 times the $25.5 billion Rite Aid reported for its 2013 fiscal year.

Takeaway

Right now, Mr. Market appears to have lost faith in Walgreen. Admittedly, management is forgoing a nice increase in profitability, but the company is doing this because it wants neither the political pressure nor the potential consumer backlash that could develop in what is, and will likely remain, its largest region of operation.

In the short run, management's decision not to invert might appear bad, but it will leave for shareholders and consumers alike the impression that Walgreen cares more about what its customers think than about making a quick buck. For this reason, combined with the fact that sales and profits are expected to soar such that the business is currently trading at 13 to 14 times 2016's forecasted profits, now might be an ideal time to consider investing in Walgreen.

Source: Walgreen Might Be A Strong Prospect After Getting Slammed